Supporters of coal have called the planned new rules from the EPA on CO2 emissions from coal-fired power generation a war on coal and have pledged to fight the rule-making process. It is true that there will almost certainly not be a new coal-fired electric generating station built in the U.S. for at least the next several years, but the hiatus won’t be caused by any specific rule. The real danger to the coal industry is uncertainty.
Investing in the electric business is about long stable returns. Electricity assets last a long time, are expensive to install, and are typically expected to provide long-term stable, if modest, returns. Since returns are spread over a long period and are stable, with limited upside (10x returns on energy infrastructure don’t exist) investors and lenders require a quantifiable and manageable amount of risk. Uncertainty in any form makes the quantification and valuation of risk in an electric generation investment much more difficult (or impossible) and severely limits investor interest.
An excellent illustration of the impact of uncertainty on electric generation investment is a recent history of the wind industry. Despite a pattern of consistent, and even retroactive extensions, the uncertainty created by the political fight over extending the Production Tax Credit for wind power has caused nearly complete cessation of new wind facilities being brought on line each time the credit wasn’t extended well in advance of expiration.
The impact of the PTC on the economic case for a wind project has been substantial and was (and still is for some projects) the difference between a profitable and an unprofitable project, so the uncertainty regarding the availability of the credit was a threshold requirement for an investor. An investor simply could not have certainty that it could earn the necessary return (or in most cases any return) without realizing value from the credit, so no investments were made. The result of this uncertainty in 1999, 2001 and 2003 is stark, as investment dropped precipitously from year to year, even though any project would have qualified for the credit because of retroactivity of the extensions.
In the most recent issue of our subscriber-only newsletter, Energy Trends Report (ETR), I took a look at the lessons learned from the decline of the US coal industry. As we have done previously, we would like to share a story from ETR with regular readers of this column. Interested readers can find more information on the newsletter and subscribe for free at Energy Trends Report.
Lessons From the Beginning of the End of America’s Coal Industry
Only a few short years ago the U.S. coal industry enjoyed a mini-renaissance with several new large power plants brought on line in 2010 and 2011, which at the time firmly entrenched coal as the dominant source of electric generation in the U.S. Since then, coal’s share of the electric market has contracted sharply, and against the backdrop of the White House’s new position on climate change is why many see an industry in serious trouble.
The U.S. coal industry has been left to fight an uphill battle with the EPA over the agency’s authority to set rules on CO2 emissions from power plants. The coal industry is fighting this battle virtually alone, as traditional fossil fuel allies sit on the sidelines (oil) with no direct stake, or wait eagerly to absorb market share (natural gas). In parallel to this new policy reality, technology developments – from advances in unconventional gas extraction to startling declines in the cost of renewable energy generation and efficiency – are redefining the economics of electricity markets.
Recently Sens. Jeanne Shaheen (D.-N.H.) and Rob Portman (R.-Ohio) reintroduced the Energy Savings and Industrial Competitiveness Act. The bill is meant to spur the use of energy efficiency technologies in residential and commercial buildings as well as in industrial and manufacturing operations. One of the key focal points of the bill is on supporting the update of building codes to integrate energy efficiency improvements and requirements.
In our energy finance newsletter a few weeks back I wrote about some possible fallout after Energy Future Holdings (EFH), the massive private equity-owned Texas electric holding company and the result of one of the largest leveraged buy-outs ever, formally warned that it might need to seek bankruptcy protection.
Last week, EFH offered a restructuring plan to creditors in an effort to avoid bankruptcy. The restructuring offer will almost surely be rejected, but may lay the initial groundwork for some type of structured resolution outside (or even inside) of bankruptcy court.
A little more than five years ago EFH was created as the vehicle for the most expensive leveraged buy-out in history when a private equity group led by KKR, TPG and Goldman Sachs Capital Partners bought the Texas energy company at a price of $43.2 billion. The failure of EFH will be hugely important in terms of the direct impact on investors, lenders and the private equity market, but perhaps more important will be what this failure means for the broader energy landscape.
The IRS issued an important piece of guidance related to clean energy finance this week. It is the annual inflation adjustment for the Production Tax Credit (PTC) and it increased the credit from 2.2 to 2.3 cents per kWh for full qualifying energy property like wind and geothermal, while the partial credit for sources like open-loop biomass and incremental hydro remained at 1.1 cents per kWh (also adjusted were the inflation factors for Indian and refined coal).
More important is what is still missing – despite widespread expectation for a first quarter release, the long awaited rules on how to determine the start of construction for purposes of determining what projects will be PTC eligible at the end of 2013 still have not been issued.
When the PTC was extended as part of the fiscal cliff deal during the holidays there was an important change in the method for determining whether a project would qualify for the credit. Historically, the qualification of property was based on the date the property was placed in service (and it’s worth noting that this rule is actually somewhat vague and the application sometimes very nuanced). Now, qualification is based on when construction for the facility begins. As long as construction starts before year-end, property is eligible for the credit.
This is a guest post from my friends Katherine Hamilton, Jeff Cramer, and Patrick Von Bargen at 38 North Solutions (one of my best resources on energy policy developments in Washington). I get updates from them on emerging energy and related policy news, and I am excited to be able to share their follow up to the State of the Union here as I thought this was a great summary of the President’s energy focus.
Following up on the President’s largely unexpected statements on climate policy in his inaugural speech, the 2013 State of the Union highlighted accomplishments to date on clean energy deployment and GHG reductions, and outlined five focus areas for his second term climate and clean energy agenda. We have included our prognosis for each of these areas.
1) Challenging Congress to pass legislation addressing climate change through “market-based solutions,” referencing Republican John McCain’s past support for his own cap and trade bill, last introduced in 2007, and threatening executive action to regulate carbon through the Clean Air Act.
Prognosis: Dems in both Houses are expected to introduce climate legislation, perhaps as a Clean Energy Standard (CES) that the President has promoted in the past and that was introduced in Senate Energy and Natural Resources in the last Congress; perhaps through introduction of a carbon tax that has the dual purpose of raising revenues; perhaps through a smaller package of provisions like Master Limited Partnerships for renewables or innovation incentives for clean technology. EPA will also continue regulating greenhouse gas emissions through its Clean Air Act mandate.
Zachary Shahan just put together statistics on the amount of solar installed by state on a per capita basis through 2012.
The results are interesting (and the full post can be found here) but none of these results are more interesting than the curious case of Arizona.
Arizona has historically been a large coal producing and consuming state and despite recent growth in solar has not been a leader on renewable energy policy or deployment.
In last week’s Energy Trends Insider (ETI) I analyzed why The Road to Chinese Shale Gas Goes Through the U.S. In addition to my article, Andrew Holland explained how the DOE Report on Economics of Natural Gas Exports Will Lead to LNG Export Permits and Robert Rapier wrote about profiting from the peculiarities of gas price fluctuations in ‘Rockets and Feathers’ — Investing in Refiners. As we have done previously, we would like to share a story from ETI with regular readers of this column. Interested readers can find more information on the newsletter and subscribe for free at Energy Trends Insider.
The Road to Chinese Shale Gas Goes Through the U.S.
China is reported to have massive unconventional natural gas resources. Technically recoverable gas reserves are forecast to be 36 trillion cubic meters, making it the world’s largest reserve pool according to EIA, and nearly 50% larger than the U.S.’s reserves. In the country’s most recent 5-year plan it laid out a goal of 6.5 billion cubic meters of production by 2015, a steep increase from the current production level of zero.
The Holistic Energy Company
I had the opportunity to spend some quality time with Dick Williams, the President of Shell Wind, discussing a range of topics including the current state of the wind industry and how Shell is positioning itself to be the energy company of the future.
Dick has been a longtime employee of Shell, and has led the wind business for more than five years. He has also joined on as a member of the executive committee for Total Energy USA, which is a new conference being held next week (November 27-29, 2012) in Houston with a goal of nothing less than tying the whole of the energy industry together in a single event.
We started out by talking about the Total Energy USA conference, and my opening question was why get involved in a new energy conference (it’s not as though there aren’t countless other energy events to spend time with). Dick said that the draw to the event was the scope and location.
Houston is the oil and gas capital of the world but there is so much more here. And if you look at the future of the industry – we all believe that at some point fossil fuels wind down. The question is just when: Is it now, 50 years, 100 years 200 years. It is going to take this energy mix going forward and why can’t Houston become the capital of that energy world – not just oil and gas.
You have solar, biomass, wind, clean natural gas, carbon capture and all these offshoots. This is another stage in Houston’s evolution, we want to be more, we want to set ourselves up for the future. At Shell we are doing a lot of work looking at the year 2025. We have a group called Future Energy Technologies. We are really doing some very interesting forward thinking stuff, and part of what we are coming up with is that it’s going to take a very diverse energy mix going forward.
This is a great idea, for the City of Houston to showcase what it can do, and for Shell to get involved and show that we have this wide range of energy options that we are looking at.
Yesterday, I explained why Obama winning re-election is not necessarily an automatic savior for the wind power industry. Basically, an extension of the Production Tax Credit (PTC) is not a given (although I give it better than even odds), and the current extension being pushed by the American Wind Energy Association would act as little more than a band aid.
While an extension of the tax credits is vital to a robust wind industry in the U.S., developers must start to consider strategic options for financing projects in a world without the PTC. Even with financing innovations, successfully putting together wind deals will be very difficult, and without these financing strategies there will be a period of time where virtually no wind projects will be financed or built in the U.S. (Read More: 5 Reasons Why Good Energy Projects Don’t Get Financed)